Prospects for Gold II

In my previous article, “My Views Regarding Prospects for Gold”, published on September 21, I addressed the consequences of the Chinese scheme “to be launched formally by the end of the year, by means of which exporters of oil to China will accept the Chinese currency, the Yuan, in payment for oil; for this deal, the Chinese have added an incentive: the Yuan received by the oil exporters will be exchangeable for gold. This gold will be “sourced”, i.e. “purchased” outside of China, for the oil exporters.”

This scheme – should China effectively carry through on its intentions – is quite revolutionary and likely to have vast consequences which will affect the whole world.

For the first time, since August of 1971- 46 years ago – gold will once again form part of commercial international transactions.

Not only is it a first in 46 years, but the Chinese are linking together both the world’s real money, gold, and the world’s most important commodity, oil, which is the fundamental motor of all the world’s productive activity.

By contrast, it is helpful to consider how the US dealt with the oil-gold nexus in 1971.

By 1970, it was evident to those running the US that it would very soon be necessary to import large quantities of oil from Saudi Arabia. Under the Bretton Woods Agreements of 1945, the immense quantities of Dollars which would shortly flow to Saudi Arabia in payment of their oil would be claims upon US gold, at the time quoted at $35 Dollars an ounce. Those claims would surely deplete the remaining gold held by the US Treasury in short order. It thus became imperative to cut the nexus between gold and the Dollar. Accordingly, on August 15, 1971, the US did just that: the US went “off gold” and continued to pay Dollars for Saudi oil. Kissinger convinced the Saudi that they should deposit their Dollars in the US banking system and hold Dollar Bonds.

The alternative, to continue under the Bretton Woods monetary system, would have meant that the US would have been forced to raise the price of gold to an enormous figure, in order to reduce the amount of gold payable to the Saudi, to a tolerable level. But raising the Dollar price of gold in that manner, would have constituted a great devaluation of the Dollar and collapsed its international prestige; that in turn, would have ended the predominance of the US as the Number One power in the world. The US was not willing to accept that outcome. So, Nixon “closed the gold window” on August 15, 1971.

The Chinese measure, which we have outlined above, will go contrary to the American decision of 1971. It is going to raise, and keep raising the price of gold, through its “oil – for Yuan – for gold” scheme, if and when it is launched as programmed later this year.

China imports about eight million barrels of oil a day. A part of these imports comes from Russia, but the majority comes from the rest of the world’s oil producers. We can estimate that about six million barrels a day arrives in China, from oil producers in various parts of the world, who will find the Chinese offer very tempting. Some will go for the gold, others may hold off.

In the final analysis, we can eliminate calculations of the Dollar price of the barrel of oil, and the Dollar price of gold. The final calculation will have to be the relationship that the world markets establish between oil and gold.

Enormous amounts of oil going to China will have to be paid in gold. An economic balance will be established between those enormous quantities of oil and a relatively tiny amount of gold with which to pay for them. Only the world markets will determine that relationship, but we can see that the intermediate figures in the relationship – the price of oil, the value of gold, the value of the Yuan and the value of the Dollar will all be affected as the economic relationship between vast amounts of oil and scarce amounts of gold is determined.

We can see that the present relationships of the intermediate figures in the oil for gold trade are going to be severely altered: Oil at $50 Dollars a barrel, and gold at $1300 or so Dollars, means that one ounce of gold at $1300 Dollars will purchase 26 barrels of oil at $50 Dollars a barrel. This is a totally unsustainable relationship, if gold is going to be paid for oil.

The present relationship between oil and gold is: 31.1 grams per ounce of gold, divided by 26 barrels = 1.196 grams of gold will purchase one barrel of oil. An unsustainably low purchasing power of gold, vis-a-vis oil. At $13,000 Dollars per gold ounce, one barrel of oil, at $50 Dollars, will be bought with 0.1196 grams of gold; perhaps we may see $13,000/oz gold in the not distant future.

There will be a permanent demand for gold in London – in increasing quantities as more oil exporters decide to receive gold for their oil – and this on-going demand for physical gold will cause a steep and continuing rise in the gold price, as it becomes necessary to adjust the huge amounts of oil delivered to China, to a relatively tiny stock of world gold available for the trade.

It is quite impossible to predict at what relationship the production of oil and the availability of gold will stabilize. But when it does stabilize, we can predict with certainty that the price of gold denominated in Dollars, or in Yuan, will be very much higher, which will mean that both the Dollar and the Yuan will have been severely devalued from their present state.

The establishment of a nexus between, oil, the world’s most important commodity and foundation of the world’s industrial activity, and gold, which is the world’s true money, will overthrow everything which we have taken for granted during the last 46 years.

China’s gold reserves, which serious analysts have calculated at not less than 30,000 tons, plus the gold held by the population (which the Chinese leadership has encouraged it to hold) will increase the wealth and influence of China in the world.

Once the Yuan has been sufficiently devalued, the Chinese government will be able to make all Yuan currency redeemable in gold, plus all Chinese private and government debt. Russia has sufficient gold reserves to follow suit.

The Chinese and Russians will then be able to demand gold in payment of their exports and be willing to pay gold for their imports.

Thus, the establishment of the all-important nexus between oil and gold is a first step that may lead, in due course of time, to the re-establishment of the gold standard in the world.

Needless to say, the very big devaluation of the Dollar will place the US in an extremely difficult situation. On this sobering subject, perhaps another outline here, in the future.

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